Friday, June 05, 2009

Pyramid Schemes in East Africa

Back in October 2006, I wrote two posts about pyramidschemes that had mushroomed and would eventually ‘burn’ thousands of investors in Kenya.

And the last year has revealed bigger pyramid scams in the form of Bernie Madoff and Alan Stanford, and just yesterday in the Kenya Parliament, some political leaders were un-masked as some of the masterminds behind some of the collapsed Kenyan schemes.

So what was the genesis of the schemes and how they ended? And more important, can they happen again?

Pyramids Rise- Early investors reaped, and told others about their success - i.e. doubling, tripling or even greater returns in a few months span - Some schemes were promoted by churches (who received tithes in return) - Pyramids opened new offices and hired new staff all around the country - New pyramids opened up cloning existing ones, but promoting a slightly different product/concept - People took loans to invest in pyramids- Peoples sold land/ shares / other assets to invest in pyramids- Pyramid investors cut across all sectors from rural farmers to bank managers

Pyramids Peak- Early investors reaped, but were greedy and ploughed back as much as they won - Pyramids grew so big they overwhelmed their managers – some stopped accepting new depositors (but not new deposits which were essential to the chain)- Banks complained they were losing deposits at a time when interest rates were very low - With IPO's few and far between, stockbrokers complained they were losing investors during a bull market period

Pyramids Fall- Banks put the squeeze on pyramid schemes, by freezing these recipient accounts with the funds in them- Pyramids without cash, tried to switch to different banks and accounts to process their funds- Banks warned other banks and the Central Bank issued some cautionary notices on schemes- Some pyramids tried to convert into cooperative societies- Some schemes bad-mouthed other pyramid schemes as unstable- When locked out of banks, pyramids moved to safe houses in residential areas where they continued to receive/pay cash - media coverage kicked in; some angry investors complained on TV about lost money and brought media crews to the safe houses showing other angry investors - Deposits dried up, and investors demanded their cash. - Pyramid schemes all collapsed largely at the same time in 2007

Sifting the rubble

Could they have been prevented?- They were unregulated: Neither the central bank, capital markets or co-operative sector regulator had over-sight over the schemes. Parliament was focused on micro-finance and anti money-laundering regulation bills. - KYC: Schemes relied on the banking system to move around the money; and if banks applied true know your customer (KYC) principles, they’d have smelled a rat - with hundreds of people queuing in their halls to deposit funds into a single customers account

Unanswered questions- What happens to the millions of shillings frozen in bank accounts?- What happened to employees of these schemes? And if rogue stockbrokers were partly brought crash down by thefts from within (internal fraud /‘robbers robbing robbers’) could this also have happened at some schemes? - Legal grey area still exists. Have any promoters being charged in court? Can any investors sue promoters for losses? The Cooperatives Ministry Task Force is looking at how to compensate investors - but is this justifiable?- Can schemes rise again? History teaches us that pyramid/ponzi schemes will happen again and again. Maybe using the mobile money transfers, or next time there’s an election. The Business Daily mentions they may have spread to neighbouring countries

I agree, great summary. Desi played out here [in Dar] the exact same way. But if i'm understanding it correctly, then the problem isn't the pyramid scheme per se, it's the freezing of the accounts when the banks felt threatened. Does that mean the schemes themselves aren't a genuinely bad idea? I'm not defending it, just trying to get a clearer picture.

for those who still think pyramids aren't bad...then i guess you haven't experienced their wrath. for your info pyramids don't give any goods or services, they exchange money for more money. Thats is it! its pure fraud.

I believe loosing money to pyramids is just a symptom of lack of proper regulations. As bankelele puts it the authorities played blind to the evils of the pyramids as they set up all over the country and swindled kenyans. and sure THEY WILL BE BACK.

Talk of legalized and legitimized Ponzi Scheme--NSSF. All Ponzi scheme have the same concept, as Kenyan middle class and working age population (pension contributor's) declines for well known reasons,some retirees with be left with claims that cannot be honored.

That is the mantra that drives most of the people who get into these schemes - be it the normal mwananchi who just wants a better house or the rich Palm Beach residents who are tired of last year's Rolls Royce.

But to curb this human weakness, the government needs to regulate such schemes and punish those involved heavily. But as the civil society too, we need to tell those who don't know better that it is a mess.

Think about it: The seller believes the price will go DOWN - hence sells knowing there's bound to be a fool who will buy the shares.

You buy thinking there's a bigger fool who will buy from you at a higher price.

Price goes up. You get greedy and hold out for more. So does everyone else. Supply goes down - demand goes up. price follows. More fools jump in.

Then someone realizes that the share is overpriced and refuses to pay more... Supply goes up - everyone wants to cash in on the next fool. Demand goes down.. fools want to wait. price follows.

Quiet moment.. nothing happens.. everyone's waiting for the next bus.

Suddenly, someone realizes that the sellers are being foolish and the shares are actually underpriced... fools sell thinking price will go lower and they will buy more shares. More buyers come in... the fools (seller) sense an upsurge in demand... decide to wait... supply goes down.. demand increases... price follows..

Our brothers & sisters in SA just discovered their largest ponzi yet! Its said to involve big name CEO's & a couple of big shots. Its in the whereabouts of a few billion Rand.Seems like, we aint seen nothing yet in E.A!